Number of illiquid stocks rises sharply

Macroeconomic headwinds on the global and domestic front and concerns over policy reforms are some factors that have resulted in volatile and uncertain market conditions through 2011. This has prompted investors to look for alternative sources of investment and, at times, remain fence-sitters on the equity markets.

A fallout has been a sharp decline in trading volume at the bourses, resulting in a rise in the number of illiquid stocks. Average combined monthly turnover of foreign institutional investors and domestic institutional investors in cash markets declined by a third, to Rs 6,804 crore from Rs 10,370 crore a year before. The average cash market turnover on the National Stock Exchange and the Bombay Stock Exchange is at five-year and six-year lows, respectively, the data suggests.

A sharp fall in mid-cap and small-cap stocks, as compared to large-cap ones, led the increase in number of illiquid stocks. The benchmark Sensex has fallen 20 per cent since its November 2010 highs, but the smaller indices have fallen more. The BSE mid-cap index has fallen 34 per cent during the same time, while the BSE small-cap index has declined 44 per cent.

"Investor interest in the mid-cap and small-cap stocks is on a decline, as they prefer their large-cap peers in these uncertain times. As a result, the liquidity and volumes are falling in these spaces," says Ravi Shenoy, AVP (mid-cap research), Motilal Oswal Securities.

The classification exercise was jointly carried out by members from BSE, NSE and the Securities and Exchange Board of India (Sebi). One out of two actively traded stocks on the BSE is illiquid, according to a list disclosed by the exchange on its website. Out of 3,344 actively traded stocks, a total of 1,717 remained illiquid in November.

As many as 325 stocks were ascertained by the National Stock Exchange (NSE) as illiquid ones last month, as compared to 148 a year before, when the markets peaked. Of these, 173 stocks have market capitalisation of more than Rs 100 crore each.

Aventis Pharma, Wyeth, Hind National Glass and Responsive Industries from the mid-cap and Sutlej Textiles, Suashish Diamonds, Warren Tea, Kanoria Chemicals, Borosil Glass Works and Bhansali Engineering Polymers from the small-cap index are among the illiquid stocks named by the exchanges. Some stocks such as Scooters India, Jolly Boards, Marathon Next Realty, Chettinad Cement and Exedy India are illiquid due to low free-float. The promoters hold 88 per cent stake each in these companies.

"Illiquid stocks tend to increase in a bear market. Liquidity will come in once the markets enter a bull phase. More, the impact cost on illiquid stocks is high, compared to liquid counterparts," states Alex Mathew, head of research at Geojit BNP Paribas Securities.

Sebi has cautioned investors before investing in these stocks. "The trading members are advised to exercise additional due diligence while trading in these, either on own account or on behalf of their clients," the stock exchanges said in a recent note to members.

"In the current market conditions, even large-cap stocks are finding it tough to attract investors. One can do nothing much about these stocks right now," states Jagannadham Thunuguntla, strategist and head of research at SMC Global Securities. However, all is not lost. "Stocks like Aventis Pharma and Wyeth have not seen much activity recently. From a long-term perspective, these companies are on a stable financial platform and one can hold on to these scrips," says Shenoy of Motilal Oswal Securities.